Understanding the Rise of China

If the sweeping economic reforms planned by Chinese leaders during the Third
Plenum can be our guide, it looks to be a promising decade for global investors.
Details released recently confirmed President Xi Jinping's concerted efforts
to move China toward a market-based economy that mirrors the West.

The plan's comprehensive nature and the level of clarity evidently pleased
investors, as many Chinese stocks experienced a pop.

We believe the positive effect on the equity markets will not be short-lived
or limited. A component of U.S. Global's investment process is to closely follow
government policies because they tend to be precursors to change. Xi's policies,
if successfully implemented, "will undoubtedly have profound long-term implications
for the Chinese economy and society at large," spanning economic, political,
cultural, social and environmental issues, says BCA.

Some say the sweeping reforms will have an impact similar to the momentous
changes following the Third Plenary Session in 1978, when Deng Xiaoping instilled
the concept of free markets and ushered in a new economic era.

"Covering 15 major areas and 60 key points, the document is specific, substantial,
comprehensive and actionable," says Jefferies. The changes are so significant,
it "rivals that of 1978, when Deng Xiaoping declared the opening of China," says
the research firm.

I asked Michael Ding, CFA, portfolio manager of the China Region Fund, to
share his thoughts regarding these sweeping changes and the potential effects
on the markets. He has fascinating insight on this subject, as Michael grew
up in rural Dalian and is of the same generation as the nation's leaders. This
age group was raised in the era of severe government controls, such as food
rations; still fresh in their leaders' minds was the stagnation of the country.

Improving market inefficiencies is one significant and positive effect, says
Michael. Currently, government interventions prevent companies from setting
competitive prices. Releasing control should allow the market to decide what
prices should be and where labor and capital should be allocated.

BCA says that three areas likely to see improvements in pricing mechanisms
include money, resources and land. Changing the pricing mechanism of money
influences the exchange rate and interest rates. The research firm says that "the
proposed reforms involve freer cross-border capital flows, improved convertibility
of the RMB and eventually a market-driven floating exchange rate system." In
addition, more liberal interest rates should allow markets to price capital
based on risk and supply and demand, says BCA.

When it comes to resources, the government plans to reduce subsidies and "administrative
meddling" in several sectors, including water, petroleum, natural gas, electricity,
transportation and telecommunications, which should allow for more competition,
according to BCA.

The reforms affecting the pricing mechanism of land will likely allow for
the equal treatment of rural and urban lands. Whereas the government formerly
seized rural land, people who live in rural areas in the future could "monetize
the rising value of rural residential land" and ease supply shortages in major
cities, says BCA.

Included in the considerable social changes are relaxing the one-child
policy and reforming the hukou
system, which is China's residency status system. Now, couples will
be allowed to have two children if one parent is an only child. This change
wasn't a surprise to us, as it follows the rise we've seen in birth rates
in recent years. As you can see below, the number of annual births in China
has been increasing since 2011. In many cases, with rising incomes, couples
can afford to pay the required fine.

Changing
the one-child policy could be the beginning of a rising demographic cycle in
China, which bodes well for a wide range of companies. The country may see
an increase in demand for residential housing and social housing, income protection
products, and child-targeted products, such as infant formula. The change may
also boost demand for larger vehicles, such as sport-utility vehicles, and
Internet companies could benefit from increased users in the years ahead, according
to Citi Research.

Demand on resources will be great, as each person requires a huge supply of
resources throughout his or her lifetime. Consider that in the U.S., over the
course of a lifetime, each person needs 72,556 gallons of petroleum, 6.63 million
cubic feet of natural gas, 978 pounds of copper, and 27,416 pounds of iron
ore, according to the Minerals Education Coalition. Even though China currently
uses fewer resources per capita compared to developed countries, the nation
is quickly catching up to developed world levels.

The
decision to reform the hukou is also equally important for resource investors. The
plan will gradually allow rural migrants to become official city residents.
While it may be expensive, "the Party has no choice but to provide migrant
workers and their families with equal access to education, health care and
other urban social services," writes Andy Rothman from CLSA.

If the government reforms the hukou, it is estimated that 600 million people
might move to the cities over the next 20 years. This includes 300 million
migrants becoming "new urban residents" and 300 million rural residents moving
to urban areas by 2030, says Citi Research. According to its data, "urbanization
could bring another 150 million surplus rural laborers to the cities."

With more workers living in cities, property sales in China's 600 third-tier
cities could significantly benefit from hukou reform, as about 100 million
migrant workers currently reside in these cities.

The Power Couple of the East

Americans recently reflected on the 50th Anniversary of the assassination
of John F. Kennedy. His death was devastating, as it essentially ended the
Camelot reign full of potential and promise for the country's future.

Today, Chinese President Xi Jinping and First Lady Peng Liyuan are ushering
in a Camelot era for China. Similar to the Kennedys, the couple symbolizes
the economic and ever-advancing strength of the country.

Xi, a princeling, is the son of Xi Zhongxun, who was among the first generation
of Chinese leadership. His father's claim to fame was in creating a special
economic zone in Shenzhen, transforming the area from a small village to one
of the fastest-growing cities in the world and one of the busiest container
ports in China.

First Lady Peng is very familiar with the limelight, as she was once more
famous than her husband, singing patriotic songs in the People's Liberation
Army. Peng is very different from previous Chinese first ladies, who were typically
invisible to the rest of the world. As the rest of the world gets to know her,
the first lady will likely broaden the appeal of China.

Looking ahead, Xi, together with the new leaders, appears to have the "confidence
and determination to lead the nation," according to Jefferies. We look forward
to watching the new leaders put their reforms in place, and agree with Jefferies
when they suggest that China could be "on the cusp of a massive multiyear bull
run."

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Frank Holmes is CEO and chief investment officer of U.S. Global Investors,
Inc., which manages a diversified family of mutual funds and hedge funds specializing
in natural resources, emerging markets and infrastructure.

The company's funds have earned more than two dozen Lipper Fund Awards and
certificates since 2000. The Global Resources Fund (PSPFX) was Lipper's top-performing
global natural resources fund in 2010. In 2009, the World Precious Minerals
Fund (UNWPX) was Lipper's top-performing gold fund, the second time in four
years for that achievement. In addition, both funds received 2007 and 2008
Lipper Fund Awards as the best overall funds in their respective categories.

Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a
leading publication for the global resources industry, and he is co-author
of "The Goldwatcher: Demystifying Gold Investing."

He is also an advisor to the International Crisis Group, which works to resolve
global conflict, and the William J. Clinton Foundation on sustainable development
in nations with resource-based economies.

Mr. Holmes is a much-sought-after conference speaker and a regular commentator
on financial television. He has been profiled by Fortune, Barron's, The Financial
Times and other publications.

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